The Southern Gas Corridor: Who Stands Where?
After almost a decade of intensive discussions and negotiations about the market and the European route for the Shah Deniz Phase 2 gas (SD2 gas), the Shah Deniz development consortium is expected to announce in two weeks time the countries to be supplied with Azerbaijani gas. It is worth noting that during the last few years we have been witnessing not only a very significant shift in the European market in general, but also in a target country markets that SD2 gas is about to be delivered in particular.
There are a host of issues that bear consideration. This article seeks to address three of them: the changing circumstances of the global gas market due to the rise of shale gas in the United States, the position that Gazprom is taking on price formation in Europe; and the question of transit across Russia for energy produced by other CIS partners, notably gas from Turkmenistan.
The Global Gas Market
On the supply side the arrival of Northern American (there is the possibility of Canadian contributions too) LNG from 2015-16 onwards, will trigger the "coastal consumers" such as Spain (mainly Fenosa), UK (BG Group & others), France (mainly Total) for further market liberalization and will drive price setting towards complete gas-to-gas indexation. However, it is not to affect the absolute price level very much as in the context of the overall European market the expected volumes are not expected to be huge. According to some analysis, the majority of Northern American LNG will be shipped to the Asian markets, where the price is expected to as high as $500/1000m3, whereas in Europe it is being calculated to be around $300/1000m3.
The rapidly growing economies of nations in the Southern Asia and the nuclear disaster in Japan have over the last 10 years created a dynamic new market for LNG. The US companies’ net back margin is very much higher in eastern direction, however such high prices could be short lived given the diversification policy that China, Japan, Taiwan & South Korea are now pursuing.
The more Europe energy demand and price drops in the internal market, the less attractive the market is for LNG suppliers. For instance, LNG supply to the flexible markets of the Northwest Europe declined by 40% in 2012. A global spot-market for LNG has been much talked about maybe it is finally about to be realized.
Undoubtedly, all this change affected the SD2 gas price negotiations with the European potential buyers of the both TAP and Nabucco West. By the time SD2 gas to arrive into the market, hub indexation certainly will prevail in the long-term contracts (LTC) and according to the Vice President on Investment and Marketing of SOCAR Mr Elshad Nassirov, SD consortium is determined to be flexible in its price setting. According to some reports, a few potential buyers of SD2 gas have submitted offers to the consortium based on 100% gas indexation, and some have even submitted offers at a discount to a hub price.
Regardless of which market orientation is selected by the SD consortium – the Central and Southeastern European market or South European, such a shift in price setting will not improve the economics of the SD2 project. If Azerbaijan has been getting $800 for the export of 1000 tonnes of oil, with gas it will be only $50/1000m3. But this will be achieved only if the average gas price at the market to be in the range $350-400/1000m3. With such market developments it is not surprising to hear that some potential buyers have offered to the SD consortium a price of $300/1000m3, which can make the entire mega project commercially not viable.
The reason why the European potential buyers are now able to negotiate such a low price with the consortium is that they have strong bargaining chip - thanks to Gazprom. During last six months Gazprom did two rounds of an impressive discount for its European customers and also have been renegotiating the price setting mechanism - for instance agreeing to increase the percentage of the hub price indexation to the LTCs. Also, for the countries along the route of the Nabucco West pipeline – Bulgaria has been given 22% discount, Romania – 5%, Hungary - 2% and Austria – 11%.
For the countries in the TAP pipeline – Greece got 12% discount (current LTC will be expiring in 2016 already; negotiations on contract extension are ongoing), Italy 11%. All the Balkan countries got from 12 to 24% discount for Russian gas. Interestingly, Gazprom has publicized all figures of discount and gas price for its customers in Europe in January of 2013.
The question might be raised: why is Gazprom offering such a large discount just now when SD consortium is negotiating its gas supply-purchase agreements (GSPA) with the potential buyers? Is the market shift in Europe the only reason or is the Microsoft-of-gas performing such unaccustomed contortions in order to challenge the Southern Gas Corridor especially the Nabucco West pipeline. In the case of Nabucco West, some of its country markets are entirely reliant on Russian supplies. Will Gazprom’s discounts be fixed for the long run in LTCs or will Russia’s gas export monopolist renegotiate them once the competitive pressure from SD2 ceases? We can but surmise. However from the point of consumer countries, it must be clear, two suppliers are better than one. And in general, economic, and EU terms, competition is better than monopoly.
In the long run the independence of nations, even the former Comecon states of the Balkans, will assert itself throughout the entire Southern Gas Corridor. Thus gas will flow not only from Azerbaijan but also, potentially, from Central Asia, Northern Iraq and the Eastern Mediterranean region (Cyprus and Israel). Russia is currently concerned about possible flows from the Caspian Region to the Southeast European markets – traditionally a Russian sphere of influence - and consequently also from new sources (Northern Iraq, Israel and Cyprus) to the European markets via a new entry point – Greece. Hence, one supposes, Gazprom’s interest in the privatization of DEPA and DESFA, which, had it been able to pursue its interest, would have given it the ability to control or challenge not only flows across Greece, but also through strategic projects in which DEPA has a stake, such as Interconnector Greece-Turkey (ITG) and Greece-Bulgaria (IGB). The latter pipeline, should TAP be selected, would constitute a key element in the prospective delivery of Azerbaijani gas to Bulgaria and the Central Europe.
As well as challenging Azerbaijan on price, Russia is challenging CIS energy producers, notably Turkmenistan, over transit. There is an October 2010 agreement between Russia and its CIS partners providing for freedom of transit across Russia, but Russia argues that this specifically does not extend to energy transit via pipelines. There have been extensive negotiations between Russia and its CIS partners on provision of an energy transit element in the protocol.
The transit provision currently under negotiation would give CIS countries the right to access the transportation system of both Gazprom and Transneft. Russia, Ukraine, Belorussia, Kazakhstan, Tajikistan, Kyrgyzstan, Moldova and Armenia are signatories to the original 2010 agreement. Three countries – Azerbaijan, Turkmenistan and Uzbekistan – did not sign up to the 2010 accord.
But these do not appear likely to yield a quick result as several CIS states are insisting that the terms of such transit should be in accordance with principles laid down in the Energy Charter Treaty (ECT).
Russia’s standpoint on gas transportation from the Central Asia to Europe and the fate of the Trans-Caspian Gas Pipeline (TCGP) highlights this point. When Turkey demonstrated in May its specific interest in receiving Turkmen gas, both for its own needs and for onward delivery to Europe, the Russian reaction came immediately.
State owned company Transneft, taking a position backed by the Russian Energy Ministry, suggested in June that the Russian government should withdraw from negotiations with CIS countries on energy transit.
Turkish intentions regarding prospective Turkmen gas supplies were demonstrated during the official visit of Turkish President Abdullah Gul to Ashgabad in late May 2013 when a protocol on gas supply from Turkmenistan to Turkey was signed.
If there were to be a Russia-CIS energy transit agreement, and if Turkmenistan were to sign up to it, then Turkmen gas could be transported in a western direction using Russia’s Blue Stream pipeline to Turkey. At present, the only other theoretical option for the transmission of Turkmen gas to Turkey is via Iran, which is subject to international sanctions.
There is, perhaps, another element worth bearing in mind: current unrest in Turkey and, in particular, references by Prime Minister Erdoğan concerning pressure from "external forces." One wonders who he has in mind, maybe he has thinking of more than just tweets and well-meaning statements from the usual Western sources about human rights and democracy?
We are straying a long way from pipelines perhaps, but we should also remember that the Eurasian region still has some powerful actors who are used to pursuing their objectives in very old-fashioned ways. Just as Baku-Tbilisi-Ceyhan (BTC) caused a shift in regional dynamics in the 1990s, now is the time to make the gas-route-to-Europe work. Any further indecision concerning Azerbaijani gas exports will play into the hands of those who naturally prefer to keep currently closed markets to themselves. So determining the final route to Europe for SD2 gas will both free some recipient countries from total dependence on a single external supplier and provide diversity for both Azerbaijan as a producer and the European Union as a consumer.
Recommendations to "just get on with it" might sound naive or frustrated, but the consequences of not making a clear decision on SD2 gas markets and pipeline construction in the very near future are I believe unacceptable. We have been talking about TAP, Nabucco etc. for nearly 10 years now - it is time to make the choice and sanction the SD2 in October, as scheduled, and move on to actual implementation.
Gulmira Rzayeva - Principal Research Fellow Center for Strategic Studies of Azerbaijan (SAM). SAM is a Natural Gas Europe Knowledge Partner.
Footnote: Article 7 of the 2010 Transit Agreement proclaims freedom of transit and requires participants to ensure equal conditions of transit on the CIS territory, but this article does not cover transportation by pipeline infrastructure. However, paragraph 4 of Article 7 obliges the parties to the treaty, within six months after its entry into force, to complete negotiations on a transit agreement that would include energy transportation by pipeline. The 2010 transit agreement entered into force in the autumn of 2012, so the new transit agreement should have been concluded by the end of March 2013. But during negotiations, which began in late 2012, it became clear that Russia’s CIS partners wanted it to based on principles of the Energy Charter Treaty of 1994 (ECT), which declares "freedom of transit of energy materials and products without distinction of the origin, destination or ownership.” The intention to ensure these principles were stated in the agreement came, in particular, came from Ukraine and Moldova.